As the Greek debt crisis goes from bad to worse, worried bankers and policy makers have started throwing the L-word around at every opportunity. Their dire warning: Greece could become another “Lehman moment,” spreading financial destruction across the globe.
“If it is Greece alone, that’s already big. But if other countries are drawn in through contagion, it could be bigger than Lehman,” Deutsche Bank chief executive officer Josef Ackermann said this week.
Invoking the shocking spectre of what happened to the global financial system when the Wall Street heavyweight collapsed in September, 2008, works extremely well as a scare tactic. U.S. policy makers and regulators badly underestimated the market disruption stemming from a sudden loss of confidence in the markets and the vast losses linked to the Lehman bankruptcy.
The bank owed $600-billion (U.S.) worldwide; its brokerage arm did billions of dollars in transactions for hedge funds; and it was at the centre of huge and opaque international derivatives dealings. Money-market mutual funds had loaded up on Lehman’s short-term notes in their search for higher returns than they could get in the U.S. Treasury market. And on top of that, giant insurer AIG had written billions of dollars worth of insurance, in the form of credit default swaps, on Lehman bonds. When the bank went down in flames, the massive bills came due from all sides. And the global financial system seized up almost overnight.
The question now is whether the crisis in one of the euro area’s smaller slum zones could trigger something similar or even worse, as Mr. Ackermann suggests. What happens if the angry Greeks reject the harsh new austerity measures being imposed on them in exchange for the next slice of their bailout loans? What about if the rating agencies decide the European Union’s efforts to “reprofile” Greek debt with the “voluntary” participation of the banks amounts to a default by any other name?
The Europeans, the International Monetary Fund and other governments and central banks will do all they can to prevent the Greek illness from wreaking widespread havoc, because the potential fallout – another global financial crisis, the unravelling of the economic recovery and the failure of the euro zone itself – is too awful to contemplate. And because they all remember Lehman.
But here’s what could happen, in a worst-case scenario, if hotter heads prevail and it turns out there is no plan B.
The dominoes:
Other euro zone countries
Debt-ridden Ireland and Portugal have already been blown off course by the Greek gale. Frozen out of the capital markets by sky-high premiums demanded by investors for the rising risk of owning their bonds, they had to seek bailouts of their own. And Spain, Italy and Belgium have all come under pressure from bond market predators, despite European efforts to fence off the Bailout Three.
The euro zone reminds risk expert Satyajit Das of a party of mountaineers roped together. As the weaker ones lose their grip, the survival of the stronger climbers is increasingly endangered. The result could be the departure from the euro of the least-competitive members and a breakup or shrinkage of the one-currency-fits-all model. A mortally damaged Europe would put a severe crimp in global prospects for economic growth and could very well trigger another slump while the U.S. economy remains weak.
The European banks
Fragile Greek financial institutions would be the first to go. They hold a combined €70-billion ($99-billion) in Greek government debt, whose value they are not required to write down as long as the principal is not at risk. If they had already been taking provisions for the reduction in value of the debt, their shareholders’ equity would be long gone.
